The hedge fund's image makeover

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Richard Baker testifies before a Senate subcommittee on Financial Management, the Budget and International Security when he was a reprsentative in Congress.
AP Photo

Today, 72 percent of the money being managed by hedge funds comes from public pension funds, university endowments and other institutional investors, Baker noted. In his own home state, for instance, the Louisiana State Employees’ Retirement System has a 30 percent exposure to hedge funds, he said.

“When you begin to look at how the industry interacts through financial intermediaries, we actually have geographic spread throughout the country,” he said. “Most members of Congress are not aware of the way in which the industry is integrated into their own communities’ financial fabric, and that’s something that we have to explain.”

Baker’s association has embraced hedge fund registration as part of financial reform — a huge shift for the industry — but differs with some lawmakers about public disclosure of filings.

The association’s board, after much discussion, concluded that it was the right public policy to register with regulators, if a bill could be constructed in a balanced way, Baker said. “We don’t mind making disclosure to regulators, but we desperately want to see the disclosure kept confidential. It’s like telling Colonel Sanders he has to give [KFC’s] recipe away to Popeye’s.”

“Having the health department come in and examine and make sure the chickens are fresh and the employees are doing the right thing, that’s one thing,” Baker concluded. “Posting it on a national billboard is an entirely different matter.”

Baker believes the industry has some attributes that lawmakers — and the public — should find appealing in the current environment and that it’s particularly important for lawmakers to understand that hedge funds serve a useful purpose in their own districts and states.

But Baker also points out that hedge funds didn’t receive any bailout money during the financial crisis and, generally, don’t expose taxpayers to such risks; hedge funds fail all the time without causing any sort of calamity.

While hedge funds are almost always described as “highly leveraged” or “highly risky,” recent studies have shown hedge funds to be far less leveraged than other sectors of the financial services industry, including commercial banks, Baker said. In fact, one study found that 27 percent of hedge funds don’t use leverage at all.

And in an era when “big is bad,” the size of the industry pales in comparison to most other sectors, he said. “We are significant, but we are by no means the elephant in the financial services industry, blundering around, causing irreparable harm to people.”

Hedge-fund managers also put their own money at risk in the funds they manage, and they don’t make money unless their investors do.

“That’s a little bit different than other sectors, where fees and bonuses sometimes seem to run one way, even while the shareholder value is going the opposite way,” he said.

Readers' Comments (2)

The demonization of hedge funds (and short sellers) has always seemed a bit odd to me. I'm not very fond of the general culture which led to the crazy risks (and stupid assumptions) many hedge funds were using, but in general investors were screened and told of the risk. Every investment approach used by hedge funds are available to individual investors (short selling, constructing complicated combinations of buying and selling puts and calls, carrying high risk). None of those tools in and of themselves are either unethical or illegal.

And short sellers perform a service to other investors by taking a hard nosed look at the financial statements of corporations. If it hadn't been for short sellers the Enron scam would've gone on much longer. Short sellers were beaten up by both the right and the left after the market downturn, and I personally believe that a lot of it was unfair.

That being said I personally kept a long distance between myself and the hedge funds. I'm an investor out of the Benjamin Grahan/Philip Fisher tradition, and the hedge funds were too much into the young cowboy speculative trading world for my taste. I study companies, keep a list and a fund of available cash in my account, and when the market dips signficantly I buy. It's dull and uncomplicated, but I always seem to do better than any fund I've ever had.